When Chapter 7 Bankruptcy Is Better than Chapter 13

Here are some reasons why Chapter 13 is not ideal for
most small business owners.

It’s Difficult to Run a Business While in Bankruptcy

All of your
personal and business property is under the bankruptcy court’s control. You
must get court permission to borrow money or to buy or sell business assets
(other than typical, day-to-day operating decisions). You can’t use credit cards,
and you have to submit monthly reports to the bankruptcy trustee. If business
picks up or you take on a side job, the extra money will have to go toward your
debts.

You Must Keep Up With Plan Payments

It might be even harder for a business owner to keep
up with plan payments for three to five years. You need to make every plan
payment on time, even if your income is seasonal or fluctuates with the
economy. If you can’t keep up with your payments, the bankruptcy judge can
modify the plan to some extent. However, if it appears that you won’t be able
to make at least the payments required by the bankruptcy code, the judge will
likely convert your case to a Chapter 7 bankruptcy or dismiss it. If your case
is dismissed, you’ll owe your creditors the balance of your debts: what you
owed at the start of your bankruptcy case, plus the interest that stopped
accruing while you were in bankruptcy, less whatever you paid through your
repayment plan.

It Costs More and Takes Longer

Although the filing fees are
comparable (currently, $310 for Chapter 13 versus $335 for Chapter 7), you will
almost certainly need a lawyer to file for Chapter 13, which can cost thousands
of dollars. In addition, you’ll usually be required to repay at least some of
your unsecured debt (although some courts approve what are known as 0% plans,
in which unsecured creditors receive nothing), something you wouldn’t have to
do in Chapter 7. What’s more, a Chapter 7 bankruptcy case is over in a matter
of months, compared to the three to five years you’ll spend in Chapter 13.

For all of these reasons, Chapter
7 personal bankruptcy is almost always the better choice for business owners.
Rather than trying to continue your
debt-ridden existing business under the close supervision of the bankruptcy
court, it usually makes more sense to close down, file a Chapter 7 personal
bankruptcy to deal with your debts, and then start a new—but similar—business
free of debt.

When Chapter 13 Is Better than Chapter 7

For some business owners, Chapter
13 might make more sense than Chapter 7:

You Want to Keep Your Asset-Rich
Business Open

Those who want to keep an
asset-rich business open during bankruptcy shouldn’t use Chapter 7, because the
trustee will likely shut the business down and sell its assets. (However, these
business owners might be best served by avoiding bankruptcy altogether and
trying to settle their debts, as discussed below.)

You Don’t Want to Lose Certain
Assets

Debtors might choose Chapter 13 if
they don’t want to lose particular, perhaps unique, nonexempt assets that they
would lose in a Chapter 7 bankruptcy. (This is a tricky area and you should
probably go over the details with a lawyer).

A Significant Portion of Your Debt
Won’t Be Discharged in Chapter 7

Debtors might want to use Chapter
13 if they have significant debts that wouldn’t be discharged in Chapter 7, but
would be discharged in Chapter 13.

You Want to Get Current on Your
Mortgage or Car Loan

Those who will need the long-term
protection of the bankruptcy court while they get current on their personal
mortgage or car payments might choose Chapter 13 rather than Chapter 7.

You Would Benefit From a Cramdown

Those who would benefit from a
cramdown might choose Chapter 13 over Chapter 7. One additional advantage of a Chapter 13 over a Chapter
7 bankruptcy is that it lets you reduce what you owe if you are significantly
upside down on certain secured debts—that is, you owe more than the collateral
for the debt is worth. You can reduce what you owe on a secured debt down to
the value of the collateral in what’s called a “cramdown.” Once you cram down
your debt to the value of the property securing it, you usually get to keep the
collateral. For more on how cramdowns work, see How
a Cramdown Works in a Chapter 13 Bankruptcy Case.